When you shop for a mortgage, you likely hear many different terms from the lender. One of those terms is the need to have hazard insurance. Is this the same thing as homeowner’s insurance or is it something different? The terms are often interchanged, when in fact, there are slight differences.
Hazard Insurance Covers you from Hazards
As the name suggests, hazard insurance covers you in the event of a hazard. A hazard is described as something that occurs because of fire, violent storms, theft and vandalism. What it does not cover is any type of injury that occurs while on your property. This is where the other components of your homeowner’s insurance come into play. Typically, mortgage lenders specifically care whether you have protection against hazards at a minimum. If you do not have insurance in place and you have the mortgage already, the lender has the right to force place the insurance on you at your cost, which can be rather costly.
The Reason the Bank Cares about Hazard Protection
You might wonder why the bank would only care about hazard protection and not about the full homeowner’s insurance policy that most homeowners carry. This is strictly because the bank wants to protect its own asset. This asset is your home – the structure, not the contents inside your home. It also has nothing to do with whether someone suffers an injury on your property. The bank wants to know that your home has insurance for hazards that cause direct damage to the home that could bring the value of the home down.
The reason the bank cares about the structure so much is because that is their backup if you default on your loan. While you borrowed the money for the full 30 years, not every borrower pays their entire loan back. Some borrowers run into trouble and wind up having to give the home back in foreclosure. At this point, the bank wants to try to sell the home again. If there is damage to the home, however, the bank will not get as much money as they anticipated for the home. When that happens, the bank takes a loss. If the damage that occurred was a result of some type of hazard, though, the insurance could cover the costs to fix it.
How Much Insurance do you Need?
Another question many people have is how much hazard insurance they must carry. If you finance your home with a mortgage, at the very least, the insurance policy needs to cover the amount of the loan. This way the lender knows they have protection should something happen down the road to your home. The lender itself will tell you how much insurance you need, but typically borrowers take out not only enough insurance to cover the value of the home, but also enough to cover the replacement cost of the home. This protects you and the bank if the unthinkable happens and your home burns to the ground. Let’s say this happens 10 years down the road. Obviously, costs will be different at that point; it might cost more to rebuild your house. With replacement cost coverage, you can rebuild your home at the current prices without worry.
The Lender is the Loss Payee
One thing you might not realize when you take out an insurance policy on your home is that the lender has a stake in the proceeds of the policy. Let’s say you take out a policy and have to use it because of some type of natural disaster. After the repairs on your home are complete, if you have money left from the policy, the lender requires knowledge of the proceeds. This is necessary so that the lender can make sure they are not taken advantage of.
There is not one mortgage program you can use that will not require you to have hazard insurance. It is the lender’s way of ensuring that they will not lose out if something were to happen to your home. Without the right insurance, if you suffered damage from a disaster, you could easily just walk away from the home, leaving the lender in the lurches for your remaining loan amount. With the right insurance policy, this cannot happen – both you and the lender have protection.
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